Corporate transactions by business owners may have family law considerations not apparent to the client (or the corporate adviser) at the time. Here, family lawyers Jenny Smith and Alexis Harper join Corporate colleague Rachel McNeill in setting out some things to consider.
For the owner of a business, there are few things worse than getting divorced. Whether your business interests are in partnerships, as a sole trader or shareholdings in private companies, they can all be seriously affected by a divorce – which, despite the statistics showing that more than a third of all marriages will end in divorce, is often not something people anticipate or plan for.
This issue came to the fore already this year when Amazon founder Jeff Bezos and his wife MacKenzie announced they were to divorce, bringing his entire ownership stake in the company into question.
Corporate lawyers are dealing with clients and their businesses on a day-to-day basis. They are unlikely to be aware of exactly what is going on in a client’s personal life, including the state of the client’s marriage and whether or not a separation is under consideration. However, corporate law advice can often have potentially significant family law consequences. So, a key question, tactfully put by the corporate lawyer, needs to be “How’s your marriage?”
Perils of a restructure
Consider this scenario. You are instructed by a (married) business owner who has decided to incorporate his business. This sole trading business had started before marriage but the incorporation is to take place during marriage.
Assets owned prior to marriage do not fall within the pot of matrimonial property available for distribution on separation or divorce. However, the step of incorporation will convert an asset that was outwith the ambit of matrimonial property into a matrimonial asset to be shared with the other spouse in the event of a subsequent separation. The business owner is unlikely to be aware of this. The business owner may decide to hold off incorporating the business if they are considering a separation.
It is critical to explain to the corporate client that there are likely to be family law consequences for this business decision. Does the client wish further advice from a family lawyer? It may shape their business decision. Could they enter into a post-nuptial agreement to protect the new business asset? Likewise, if you are consulted by a business owner who reveals they are about to marry, consider whether a pre-nuptial agreement would be beneficial, to ring-fence pre-marriage assets and deal with possible transmutation during marriage.
What about when you are instructed by a business owner who has, on the advice of their accountant, tax adviser or bank, decided to proceed with a corporate restructure? The business may have been acquired before marriage, but how will the restructure change the treatment of this asset on divorce? Consider the example of a husband holding shares in a limited company prior to marriage. Those pre-marriage shares are not matrimonial property. Parties marry. The company goes from strength to strength. New subsidiary companies are set up. There is then a company restructuring, with a new parent company. Parties separate.
At this point the shares have changed nature; the husband’s shareholding in the new parent company is within the ambit of matrimonial property, albeit with the possibility of arguing special circumstances, namely the source of the funds – non-matrimonial – used to acquire the new asset. However, “special circumstances” is a discretionary argument, meaning that it is up to the court to decide whether or not it applies to a particular case. This lack of certainty is clearly not ideal. Coupled with this, family case law on company restructures is not settled; it is very much dependent on the particular facts and circumstances of each case.
A corporate lawyer needs to be aware when advising a client about a business restructure that there may be significant family law consequences. We have seen instances where a business owner has instructed our Corporate team to carry out a corporate restructure on the back of favourable tax advice, but when the business owner understands that the transaction will have family law implications they decide not to proceed.
Share transfers: a pertinent question
Consider another scenario. A majority shareholder in a successful family business instructs you to transfer his shares to another family member. No information is given or asked about his personal circumstances. You proceed with the work. Fast forward several months and you have received a specification of documents under an application for commission and diligence in a Court of Session divorce action.
Your client is alleged to have alienated matrimonial property with the intention of defeating his spouse’s claim for financial provision on divorce. You are now faced with having to collect all the documents in your possession which appear to fall within the terms of the specification.
Your client is struggling to come up with a valid reason for a share transfer carried out against a backdrop of what you now know was a marriage in crisis. If only you had spoken to your family law team.
A stake in the business?
Often, a business owner wants to involve his or her spouse in the business, for instance, by putting the spouse on the payroll and giving them marketing or other administrative roles. This often makes sense from a tax perspective. However, corporate and employment lawyers need to be alert to the consequences of this structure on separation. If the business owner attempts to sack the spouse, they are then at risk of an unfair dismissal claim and/or a claim for aliment following loss of the income from employment. There is also the danger that the employee spouse argues they have contributed to the growth of the business and, in turn, should share in its value, albeit the business was set up before marriage and is not matrimonial property.
Where the business owner’s spouse is, or will become, a shareholder or partner in the business, it is worth considering with the owner client whether a shareholders’ agreement or partnership agreement should be put in place. If the personal relationship between the owner and spouse deteriorates, decision making in relation to the business can become fraught with difficulties. We have seen situations where a disgruntled spouse who has an interest in the business can hold their spouse to ransom or prevent a sale of the business. Putting in place appropriate governance documentation in “the good times” can avoid issues if the personal relationship between the spouses deteriorates.
Sometimes, the business owner will want the spouse to hold shares, so that dividends can be paid to both individuals, even where the spouse is not involved in the business. It is important to consider the position on separation when discussing the extent of shareholding to be given to the spouse. Ensuring the business owner retains more than 75% of the shares means that they retain control of all significant decision making and also means that the other spouse’s shareholding will attract a significant minority discount for valuation purposes, hopefully making it more feasible for the owner to contemplate purchasing the shares on separation.
However, we have seen situations where the spouse with the minority shareholding has argued that the company was operated as a quasi-partnership, in an attempt to counter the minority discount argument. This argument is likely to hold more weight if at some point the business was actually operated as a partnership before becoming a limited company. In order to protect the business owner client as best you can, therefore, it is important to consider any change in business structure carefully, and be mindful of the consequences of such changes on any future separation.
We have also seen instances where a business owner suspects separation is likely and decides to retain profits in the (non-matrimonial) business in an attempt to reduce the available pot of matrimonial property. This could backfire if the other spouse can persuade the court that there was no sound business reason for retention of the profits, for example where profits were not retained historically.
The corporate adviser’s line
All of these scenarios present difficulties for corporate advisers. So, how do you deal with this in practice? You are not expected to specialise in family law or be aware of the exact implications of the corporate decisions your client makes. Our advice would be to explain to the business owner that the course of action they are considering could have family law implications in the event of a separation or divorce, and recommend they take specialist advice from a family lawyer. Provided you have highlighted to the client (preferably in writing) that there may be family law consequences arising from business decisions, you have done your best to protect your client. Failure to do so could leave you exposed to a complaint from an irate client going through an acrimonious divorce.
This article appeared originally in the Journal of the Law Society of Scotland, March 2019.